FOOLISH FOUR PORTFOLIO
History of the Dow
The Dow Jones Averages

By Randy Befumo (TMF Templr) and Alex Schay (TMF Nexus6)

It was not until the spring of 1896 that Dow had developed his ideas to the point where he completely removed the railroad issues from his general market Average and created two separate Averages -- the Industrials and the Railroads. Now the Wall Street Journal reported an independent Railroad Average as well as an Average composed entirely of industrial and natural resource concerns -- the Dow Jones Industrial Average (DJIA). Although they first appeared on May 26, 1896, the Industrials were not reported in the Wall Street Journal on a regular basis until October 7th of the same year. Their starting point on October 7th? A mere 40.94 -- a long way from where the DJIA sits as of this writing.

Early on, the Industrials were a dynamic Average, changing composition on an almost monthly basis. Because the Dow Jones Industrial Average was supposed to represent the current business environment, Charles Dow actively sought to include the key industries of his time -- sugar, spirits, leather, cordage, tobacco, gas, lead, rubber, coal, iron, and electrical products. This is a far cry from today's Index, dominated by retailing, oil, technology, pharmaceuticals, and entertainment companies.

The original Industrial Average included names like American Cotton Oil, American Sugar, Distilling & Cattle Feeding, Laclede Gas, National Lead, and U.S. Rubber. (See The Dow, 1884-1886for the full list.) Today's Average has companies like American Express, Walt Disney, Merck, and United Technologies filling its ranks. (See The Dow Today for the current list.)

The only company on the original list of Industrials that has managed to endure is General Electric -- although it has been removed from the Index twice (only to be added back again later, obviously). The original Railroad Average was replaced by the more generalized Transportation Average after a number of trucking, airline, and air-shipping concerns were added to it in 1970. These changes included the first Dow stocks to come from the Nasdaq instead of just from the New York Stock Exchange -- first Roadway Services and then Yellow Corp. (NASDAQ: YELL).

The last development was the fifteen-stock Dow Jones Utilities Average, making its first appearance in 1929.

Despite public perception to the contrary, the Dow Averages have continued to change in recent years -- and these alterations are far from accidental. A new component has been added, on average, every three years since the inception of the Average.

The editors of the Dow Jones Indices oversee any shifts in the composition of the Averages and see that periodic adjustments are made to ensure that the Averages continue to reflect the current business climate, as well as to compensate for mergers and bankruptcies involving Dow stocks. This function has maintained Charles Dow's original commitment to ensure that the mix of companies on the Averages remain analogous to the broader market.

A number of factors are considered when choosing a company to represent a specific industry in the Dow. Is the company a leader? How long has it been around? Does it treat its shareholders well? What is its reputation in the industry? Dow companies have to be leaders in a particular industry or sector. The Dow has traditionally been made up of corporate giants, massive companies whose shares have been publicly traded for decades. Although companies like Coca-cola (NYSE: KO) or Kodak (NYSE: EK) might appear outdated compared to the AOLs of the world, the mere fact that Coke and Kodak have been multi-billion-dollar companies for decades suggests an incredible staying power that their juvenile competition has yet to demonstrate. Although sometimes the presence of companies like Caterpillar (NYSE: CAT) on the Index might make it appear antiquated, many investors are too quick to judge -- in this instance forgetting that CAT is a global company and that people just love moving dirt around.

An example of the logic used to maintain the weighting of the Dow is illustrated by the changes that were made in 1985, after Dow component General Foods was bought-out by tobacco giant Philip Morris. The sudden addition of Philip Morris to the Average upset the industry weighting by doubling the number of tobacco companies (American Brands, formerly American Tobacco was already there). As a result, the editors of the Index decided to drop American Brands entirely and add McDonald's to the Industrial Average in order to better represent the restaurant industry.

As far as bankruptcies, in its 100-year history, the only company that has fallen off of the Dow Industrial Average due to financial difficulties is the John Manville company, which was caught in a wave of litigation relating to its premiere fire-retardant product -- asbestos. Chrysler's run-in with red ink, that was eventually resolved by a bail-out from the U.S. government, was probably responsible for its deletion in the early '80s; although the company never did, in fact, go bankrupt. The only other high-profile bankruptcy was Texaco, after the attempted acquisition of Getty Oil resulted a major fine due to a breach of contract. Even Exxon's Valdez disaster and Union Carbide's Bopahl tragedy were not enough to get them kicked off the index.

Continue »

 History of the Dow

  • The Dow 1884-1886
  • The Dow Today
  • Charles Dow, Revolutionary
  • Dow's Theory
  • Dow Jones Averages
  • Dow Mechanics